If you purchased an annuity but later decide that it no longer fits your financial plan, you may be wondering what you can do with it. You could surrender it or cash it out but that could trigger fees and taxes. Transferring the annuity to a new annuity company or to one of your heirs is another possibility. If that’s something you’re interested in, it’s important to be aware of annuity transfer rules set by the IRS.
Consider working with a financial advisor as you weigh the pros and cons of annuities, as well as taxes on such policies.
In simple terms, annuities are insurance contracts. When you buy an annuity, you agree to pay a premium to the annuity company. Premiums may be paid as a lump sum or in installments. The annuity owner pays the premiums in exchange for eventual payments from the insurance company. The annuitant is the person whose life expectancy is used to calculate those payments. The owner and the annuitant can be the same person.
The annuity company agrees to make payments back to you, according to the terms of the contract. If the annuity is immediate, those payments may begin within one year of purchasing the contract. If the annuity is deferred, you may be waiting several years for payments to kick in.
Fixed annuities offer a guaranteed rate of return. Variable annuities generate returns based on the performance of an underlying mix of investments. Annuities can be used to build wealth and create additional streams of income for retirement.
Annuity transfers are transfers of either the contract itself or ownership of the contract. Examples of annuity transfers include:
Transferring an annuity is different from naming a beneficiary. An annuity beneficiary has the right to receive funds from the contract once the primary owner passes away. So, you might name your spouse or an adult child as a beneficiary to your annuity.
When you transfer an annuity, you’re typically making some type of material change with regard to where the contract is held, the terms of the contract or who is listed as the owner.
Annuity transfer rules govern which types of annuities can be transferred. There are two key rules to understand:
It you have a deferred annuity it doesn’t matter if it’s a fixed or variable contract. As long as you haven’t started receiving payments from it yet you can transfer it. If you’re not sure what you have, it may be helpful to contact your annuity company to learn more about your contract.
Whether transferring an annuity is a good idea or not can depend on the specifics of your situation. Before making a move, it’s important to weigh what you stand to gain or lose and your end goal for initiating an annuity transfer.
For example, say you’re contemplating transferring your annuity to a different annuity company. That could be a good move if you:
On the other hand, transferring an annuity might do more harm than good if it means paying steep surrender charges or losing some of the benefits included in your current contract. If you’ve included riders with your annuity, it’s important to know whether those benefits will transfer if you decide to move your annuity elsewhere.
Talking to a financial advisor can help you decide if transferring an annuity is a good option and if so, where you might want to consider transferring it. Your advisor may also be able to offer help if you have a special situation, such as a division of assets during a divorce that might require you to transfer an annuity.
Yes and no, depending on how you’re transferring an annuity. If you’re simply trading out one annuity contract for another, you can do without a tax penalty if you’re following the IRS rules for 1035 exchanges.
A 1035 exchange allows you to swap one annuity contract for another, as long as the contracts are similar. In order to complete a 1035 exchange to transfer an annuity into a new contract, you would need to:
You’ll need to report a 1035 exchange of annuity contracts on your federal tax return. The annuity company that’s transferring the contract should issue you a Form 1099-R that you can use to report the exchange on your taxes. Time is of the essence when completing a 1035 exchange. The entire process must be completed within 30 days. Additionally, annuity transfer rules require that the account owner must be the same.
What does that mean if you’re hoping to transfer ownership of the annuity to someone else? You could still do that but it wouldn’t qualify as a 1035 exchange. In that instance, any transferred amounts are typically treated as taxable distributions. That means you would owe income tax on any earnings and if you’re under age 59 ½, you’d also pay a 10% early withdrawal penalty.
Annuity transfers between spouses may qualify for an exception to that rule. If you’re transferring an annuity to your spouse because you’re divorcing, and the transfer occurs within one year after the marriage ends it would be tax-exempt. However, your former spouse would be responsible for any tax implications if they decide to withdraw money from the annuity early once the transfer is complete.
Annuity transfer rules can be complicated and it’s important to understand how they work in order to avoid tax consequences. If you have yet to purchase an annuity but are considering buying one, you may want to give some thought to whether transferring the contract is something you might need to do down the line.
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Rebecca Lake, CEPF®Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children. Rebecca also holds the Certified Educator in Personal Finance (CEPF®) designation.
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